Chapter Strategic Capacity Planning for Products and Services McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved Learning Objective: Chapter You should be able to: Summarize the importance of capacity planning Discuss ways of defining and measuring capacity Describe the determinants of effective capacity Discuss the major considerations related to developing capacity alternatives Briefly describe approaches that are useful for evaluating capacity alternatives Instructor Slides 5-2 Capacity Planning Capacity The upper limit or ceiling on the load that an operating unit can handle Capacity needs include Equipment Space Employee skills Instructor Slides 5-3 Strategic Capacity Planning Goal To achieve a match between the long-term supply capabilities of an organization and the predicted level of long-term demand Overcapacity operating costs that are too high Undercapacity strained resources and possible loss of customers Instructor Slides 5-4 Capacity Planning Questions Key Questions: What kind of capacity is needed? How much is needed to match demand? When is it needed? Related Questions: How much will it cost? What are the potential benefits and risks? Are there sustainability issues? Should capacity be changed all at once, or through several smaller changes Can the supply chain handle the necessary changes? Instructor Slides 5-5 Production Capacity Planning Labor Capacity Equipment Capacity Packaging Capacity Material Receiving Capacity Production Capacity Equipment Maintenance Capacity Facility Capacity Inventory Storage Capacity Sales Force Capacity Measures of Capacity We measure the capacity of a plant, machine department, worker, hospital, etc., either in terms of output (number of units or number of pounds manufactured) or in terms of input (e.g number of machine hours, machines, labor hours, …) A major function of capacity planning is to match the capacity of the machine or facility with the demand for the products of the firm Capacity Planning Horizons Capacity planning can be classified into three planning horizons: Long range planning horizons of one year or longer to provide sufficient time to build a new facility, to expand the existing facility or to move to a new facility due to expected changes in demand Medium range planning horizon ranges approximately from one month and less than a year At this level of planning, decisions or activities include acquisition of a major piece of machinery and subcontracting Short range planning horizon covers capacity planning activities on a daily or a weekly basis and are generated as a result of disaggregation of the long or medium range capacity plans These activities include machine loading and detailed production Capacity Planning Output rate is uncertain because: Employee absences Equipment breakdown Vacations Material delivery delays and shortages Quality problems and rework Capacity Decisions Are Strategic Capacity decisions impact the ability of the organization to meet future demands affect operating costs are a major determinant of initial cost often involve long-term commitment of resources can affect competitiveness affect the ease of management have become more important and complex due to globalization need to be planned for in advance due to their consumption of financial and other resources Instructor Slides 5-10 Cost-Volume Analysis TC = FC + VC VC = v x Q TR = R x Q P = TR – TC P = R x Q – (FC + v x Q) P = Q(R – v) – FC Q = (P + FC) / (R - v) QBEP = FC / (R – v) Cost-Volume Analysis Example Given FC = $6,000; VC = $2 / unit; Revenue = $7 / unit Q1 : Breakeven point? QBEP = FC / (R – v) = 6000 / (7-2) = 1,200 units Q2 : What is the profit if 1,000 units are sold? P = Q(R – v) – FC = 1,000(7-2)-6,000 = -1,000 Q3: How many units must be sold to realize a profit of $4,000? Q = (P + FC) / (R - v) = (4,000+6,000)/(72) Cost-Volume Analysis Example Given the following costs for a make or buy decision: Make Annual fixed cost Variable cost/unit Buy $150,000 None $60 $80 Q1: For an annual volume of 12,000, should we make or buy? TCmake = 150,000 + 60 x 12,000 = $870,000 TCbuy = 80 x 12,000 = $960,000 Decision: make Cost-Volume Analysis Example Q2: Determine the volume at which the two choices would be equivalent TCmake = 150,000 + 60 x Q TCbuy = 80 x Q TCmake = TCbuy 150,000 + 60Q = 80Q Q = 7,500 units Q3: Over what range of volume the “buy” decision is preferred? Cost-Volume Analysis Example Make Decion: Buy if Q < 7,500 Cost $ Q = 7,500 Buy Units Q Make if Q > 7,500 Cost-Volume Analysis Example Alternatives: Buy 1, or machines: # of Fixed Output Machines Costs Range $ 9,600 0-300 $ 15,000 301-600 $ 20,000 601-900 Variable cost is $10; revenue is $40 per unit Q1: Determine QBEP for each output range 1: QBEP = 9600/(40-10) = 320 > 300 not BEP 2: QBEP = 15000/(40-10) = 500 units 3: QBEP = 20000/(40-10) = 666.67 Cost-Volume Analysis Example If projected annual demand is between 580 and 660 units, how many machines should the manager purchase? Answer: machines (why?) Break-Even Problem with Step Fixed Costs Figure 5.7b $ BEP TC BEP2 TC TC TR Quantity Multiple break-even points Cost-Volume Analysis Assumptions Cost-volume analysis is a viable tool for comparing capacity alternatives if certain assumptions are satisfied One product is involved Everything produced can be sold The variable cost per unit is the same regardless of volume Fixed costs not change with volume changes, or they are step changes The revenue per unit is the same regardless of volume Revenue per unit exceeds variable cost per unit Instructor Slides 5-55 Financial Analysis Cash flow The difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes Present value The sum, in current value, of all future cash flow of an investment proposal Instructor Slides 5-56 Decision Theory Helpful tool for financial comparison of alternatives under conditions of risk or uncertainty Suited to capacity decisions See Chapter Supplement Waiting-Line Analysis Useful for designing or modifying service systems Waiting-lines occur across a wide variety of service systems Waiting-lines are caused by bottlenecks in the process Helps managers plan capacity level that will be cost-effective by balancing the cost of having customers wait in line with the cost of additional capacity Some Possible Growth Patterns Volume 0 Time Cyclical Time Volume Growth Decline Time Volume Volume Figure 5-1 Stable Time Some Possible Growth Patterns A B C D E F Effective Capacity Demand Operations Strategy Capacity planning impacts all areas of the organization It determines the conditions under which operations will have to function Flexibility allows an organization to be agile It reduces the organization’s dependence on forecast accuracy and reliability Many organizations utilize capacity cushions to achieve flexibility Bottleneck management is one way by which organizations can enhance their effective capacities Capacity expansion strategies are important organizational considerations Expand-early strategy Wait-and-see strategy Capacity contraction is sometimes necessary Capacity disposal strategies become important under these conditions Instructor Slides 5-61 ... major function of capacity planning is to match the capacity of the machine or facility with the demand for the products of the firm Capacity Planning Horizons Capacity planning can be classified... greater capacity cushion Organizations that have standard products and services generally have greater capacity cushion Instructor Slides 5-18 Steps in Capacity Planning Estimate future capacity. .. supply chain handle the necessary changes? Instructor Slides 5-5 Production Capacity Planning Labor Capacity Equipment Capacity Packaging Capacity Material Receiving Capacity Production Capacity Equipment